April was not a good month for the S&P 500, with the stock index falling for the first time since November 2011. Some asset classes actually rose in April, however. To wit: natural gas was up 7% in April, its largest monthly price increase in 13 months! 

Source: Bloomberg

Cooler weather – 70% of U.S. natural gas consumption is for home and business heating – and the substitution of 6 billion cubic feet (bcf) per day of cheap and clean natural gas for dirty and increasingly- regulated coal-fired power generation are the primary reasons for natural gas’ April gain.

A 6 bcf per day increase in use of natural gas by U.S. power plants in 2012 is substantial when one considers that total U.S. consumption of natural gas is around 66 bcf per day. That’s a 9.1% increase. But the price revival may be short-lived as incessant gas drilling via fracking technology produces more supply and the warmer weather of spring spreads across the country and demand for heating disappears. In 2011, U.S. natural gas production grew by a record 4.5 bcf per day while demand growth was only 920 million cubic feet per day.  Natural gas inventories in North American storage facilities recently hit record-high levels, with U.S. gas storage increasing during March for the first time since 1977. Storage is already at 60% to 70% capacity and some analysts are expecting gas storage needs to exceed 100% capacity by October. If that happens, look out below.

No wonder that Elliott Gue of the Energy Strategist predicts that natural gas prices will remain depressed “over the next 2 to 3 years” and Roger Conrad of MLP Profits sees natural gas prices retesting the 1992 all-time low near $1 per mcf!

Natural Gas is in a Long-Term Bear Market

Prior to the recent price jump in natural gas to end April, the commodity hit a 10-year low spot price of $1.84 on April 20^th. In other words, April’s entire price gain occurred in the last 10 days of the month! Bear markets are famous for exhibiting the most intense short-covering rallies and rarely end coincident with prices hitting multi-year lows for the first time, so natural gas bulls need to temper their excitement. The fact remains that natural gas is in a vicious seven-year bear market, having declined an astounding 86% since it hit its all-time high of $15.39 per bcf in December 2005 in the wake of Hurricane Katrina. The December 2005 peak price was retested in July 2008 but only got as high as $13.31 on the retest before starting its final horrifying collapse below $2 earlier this month:

Source: Bloomberg

Long-Term Prognosis for Natural Gas is Bullish

Although the short-term trend continues to look bleak, the long-term outlook for natural gas prices is much more bullish. Jeffrey Gundlach, bond-investor extraordinaire, recently stated that natural gas is his “best investment idea.” He notes the amazing similarity between natural gas in 2012 and gold in 1997 and thinks that natural gas could be entering a huge bullish phase just like gold did after bottoming in 2000. Although gold didn’t bottom until 2000, the vast majority of its losses occurred by 1997 with the precious metal muddling along the bottom for the next three years. Anybody who bought gold by the end of 1997 didn’t make money for the next three years, but didn’t lose much either. After making its final bottom in 2000, gold went on to post 11 consecutive years of gains, rising six fold!  If natural gas were to follow suit, its big rally should start sometime in the 2015-16 timeframe.

Price projections based on past chart patterns aren’t very persuasive by themselves, but when they are combined with a compelling fundamental story, the projections become much more believable. In the case of natural gas, the supply-demand balance is set to radically change by the exact same 2015-16 timeframe as the charts suggest.

LNG Exports are a Game Changer

Demand for U.S. natural gas will skyrocket with the introduction of liquid natural gas (LNG) exports. Unlike crude oil which can be easily transported between countries via shipping, natural gas must be liquefied at very cold temperatures (minus 260 degrees Fahrenheit) before it is stable and safe enough to ship. Such liquefaction requires very expensive high-tech equipment and infrastructure costing in the billions of dollars. Up to now, such infrastructure has not been built in the U.S. on a large scale, but this is about to change.    

On April 16^th, the Federal Energy Regulatory Commission (FERC) approved Cheniere Energy’s (NYSE: LNG) application to construct an LNG export terminal in Louisiana and sell LNG to “markets worldwide.” Prior to this historic FERC decision, the only LNG exports permitted were to countries with which the U.S. has a free-trade agreement (FTA). Since virtually all large LNG importers don’t have an FTA with the U.S., expanding LNG exports to non-FTA trading partners is a very big deal.

The first two sections of Cheniere Energy’s LNG export terminal are scheduled to commence operations in – you guessed it – the 2015/2016 timeframe. At least eight other companies have filed similar applications for LNG export terminals, including Sempra Energy (NYSE: SRE), Dominion Resources (NYSE: D), and Energy Transfer Equity (NYSE: ETE). These applications will not be considered until after a market-impact study of LNG exports is completed by independent consultants of the U.S. Department of Energy (DOE) in late summer 2012. A January study by the Energy Information Administration (EIA) concluded that wide-scale LNG exports could cause U.S. natural gas prices to rise by as much as 54% by 2018, but the extremely aggressive assumptions underlying the EIA report have been soundly criticized as unrealistic. Another January report by the Brookings Institution – a Washington think tank – reached a far different conclusion, stating on page 33:

Exports of up to 6 bcf/day will have modest impacts on domestic prices.

While the EIA report appears to assume that the international community could absorb the entire LNG export capacity of 10 bcf per day (roughly equivalent to 80 million tons annually), Brookings assumes that actual international demand would be far less than this maximum export capacity. Don’t forget that the U.S. will be competing with several other LNG exporters, including Australia and Qatar. But it’s also true that the Panama Canal is scheduled to be widened by 2014 to allow LNG tankers to pass through, which will reduce U.S. transportation costs and make U.S. LNG  exports even more price competitive.

In any event, with conflicting conclusions out there in the public domain, the late-summer release of the second DOE report on LNG exports is widely anticipated by all parties. The odds of further LNG export approvals is likely because DOE Secretary Steven Chu has already publicly voiced his support for LNG exports because they would create thousands of jobs.

The economics of LNG exports are compelling because of the tremendous price differential between natural gas prices in the U.S. compared to Asia and Europe. According to The Institute of Energy Economics, Japan, while U.S. natural gas prices are at $2 per bcf line, prices in Asia are running $15-$16 per bcf and prices in Europe are running about $10. The U.S. economy would generate significant additional wealth if it could sell natural gas at prices 5 to 8 times higher than are currently available in the domestic marketplace. Of course, the price gap would narrow once LNG exports commenced – with U.S. prices rising and Asian/Europe prices falling – but the gap would likely still be significant.

Bottom line: natural gas prices could continue falling in the short term, but buying natural gas and natural gas-related companies as U.S. LNG exports get underway in 2015 could turn out to be one of the greatest investments of the next decade.
 
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